Asia shifts to debt markets

IFR, January 2013

2012 was an outstanding year for Asian debt capital markets, just as equity issuance faded – a reversal of the traditional mix in Asia. So was this just a function of rates and markets, or is there a more significant shift taking place?

The increase in DCM volumes has been momentous. Total Asian debt issuance in G3 was $115 billion up to early November in 2012, compared to $73 billion for the whole of 2011. “You’re talking about a 48% increase year to date, and the year hasn’t ended yet,” says Paul Au, head of debt capital market syndicate at UBS in Hong Kong. Moreover, it’s been a fairly broad-based improvement. “The issuance has been across the region, from many different countries, with a good mix of corporate and sovereign issuance and a pick up in high yield issuance,” says Au.

One interpretation is that the increase, and the decline in ECM volumes, is a function of temporary circumstances. “It’s part of a global phenomenon of record low interest rates and credit spreads that have been tightening through the year,” says David Ratliff at Citi. “You’ve got US Treasuries at all time lows, and in a lot of local currency markets you’ve also seen rates come down to dramatically low levels. Issuers are taking advantage of that.”

At the same time, equity issuance has been problematic in such difficult markets. “It’s been challenging for ECM,” says Herman van den Wall Bake, head of fixed income capital markets for Asia at Deutsche Bank. “The reduced growth prospects in the region, and the fact that margins have come under pressure, have impacted valuations and investor appetite. Many companies have opted not to dilute themselves at these levels and have looked at the debt market instead.”

But there are broader shifts at work too. If this was just a case of people ignoring equities for all forms of debt we would have seen loan volumes rise too, but that hasn’t been the case. “It’s not a function of leverage all of a sudden going up,” says Bake. “The syndicated loan market is down 20% year on year. Instead, what you’ve seen is a trend away from bank financing and towards bond financing.”

People have been expecting this to happen for some years, but the exceptionally high liquidity among Asian lenders has stopped it taking place. Earlier this year, however, banks globally began to be squeezed and the term and quantum of lending began to change. “Hong Kong blue chips, instead of getting five or seven year loans, were only getting three year loans,” says Bake. And with margins on those loans increasing too as banks passed on their borrowing costs, bonds started to look much more attractive. “The minute bond markets reopened in January there was a stampede of corporates trying to lock in term funding,” Bake says. “And as the year progressed, and we saw base rates rally and credit spreads tighten, the appeal of terming out debt was compounded.”

This has become increasingly clear through 2012 as rates from the issuer perspective have got better and better. Take Hutchison Whampoa. It launched a five and 10 year bond in January, raising US$1.5 billion at 3.5% and 4.625% respectively. It returned in November for the same volume and tenor, this timing paying 2% and 3.25% respectively. “They’ve basically saved themselves 150 basis points running, in the same year, with just 10 months in between,” says Bake.

On top of that, there is a continuing change in the nature of the Asian investor base. This manifests itself in a number of ways, from the growth in the number and scale of sovereign wealth funds, to the steady development of pension funds, and the increasing appetite for debt securities among private banking clients. “The Asian investor base has become a lot more independent, which means issuers from the region are able to depend a lot more on Asian investors alone for their issuance, rather than needing global or 144a transactions,” says Au.

Ratliff agrees. “Over the last few years you’ve seen the local institutional and private banking client base grow in terms of its importance to getting credit deals done,” he says. “Going back several years, there was a lot of demand for Asian debt deals first from Europe, secondly from the US, and then the local Asian institutional client base. Since then you’ve seen Europe shrink a bit, and a big rise in Asian appetite for new issuance.”

Correspondingly, issuers can raise money with confidence in the local bid without having to worry about the state of the US market at any given time. Au points to a $750 million deal UBS joint led for Citic Pacific, raising the money in Reg S format. “Two or three years ago if someone had asked me, should I go to the States and do a 144a, my answer would have been: if you want $750 million, then absolutely you have to go to the US. Now, the answer is no.”

Bake agrees. “In the past you would have thought a Reg S deal was good for $500 million, or at a stretch $750. Now it’s a billion, and there are many examples of order books in excess of $10 billion. We’ve never seen this, ever.”

And it’s not just the scale of the Asian bid that is changing; it has many different components, all growing in sophistication. One is private wealth. “There is a notable increase in appetite from private bank clients and family offices,” says Ratliff. “Especially in Hong Kong you’ve seen an increase in the number and size of family offices, some of which operate almost like hedge funds and get involved in the new issue space in both debt and equity.”

Au, too, says the private banking bid has “probably increased. It’s a reflection of liquidity among individual and high end investors. A lot of them are putting more money into fixed income and that has created a deep liquidity pool for Asian credits.” Au also notes an important shift in the way international investors are moving their Asia analysts into Asia – which sounds obvious but has not always been the case. “The big US and European accounts are setting up offices in the region so they can trade Asian credits in Asian time zones,” he says. “In the past, for some of these accounts, you had to pay a visit to them in London or the States. Now you can see them in Singapore and Hong Kong.”

Additionally, the growing scale of Asian central banks is helping to drive the curve out to longer tenors, with longer-term deals becoming more commonplace. Where once Asia was known for shorter-dated paper, that’s no longer the case. “Five to 10 years is the sweet spot and we’ve seen some very good interest in 30 year deals for strong credits,” says Ratliff; Citi has been on 30-year deals for Temasek, PTT and PLN this year, and most recently a 30-year Reg S deal for China Overseas Land, the first of its kind for a Chinese real estate company.  “You’ve even seen some longer tenor deals getting priced inside the spreads of shorter tenor deals,” Ratliff says. “That’s a sign of robust appetite. It’s a brilliant environment for issuers to be tapping debt markets.”

In terms of the type of issuance that has characterised the year, Bake highlights investment grade corporates as the main driver. “Investment grade has been open all year, as investors are more comfortable owning strong corporates with steady cash flows,” he says.

As another banker puts it: “Right now, would you rather own a government bond or a bond from Coca-Cola? Which is the safer credit? Most investors would rather own Coke. And the same applies in Asia. If you want peace of mind, you want a strong corporate with steady cash flows.”

Opinion is divided on high yield. Au thinks it’s done well. “Private corporates have shown a very strong pick-up in high yield; they make up about 18% of total issuance,” he says. “With rates remaining low investors are looking for yield and moving down the credit curve.” Bake is not so sure. High yield, in his view, “has not performed as well on a relative basis. That is a function of their diminished growth prospects: many companies that used to have margins of 20 or 25% have come down to low doubly digits. Borrowing 10% to earn 13% doesn’t seem so compelling.”

So where to from here? Few see any significant change coming in the global rate environment over the next year, and therefore no obvious reason to expect a major reversal in issuance trends. “Next year, unless you see a big back-up in rates or credit spreads, the new issuance environment is going to remain pretty robust,” says Ratliff. “There’s insatiable appetite from institutional investors for debt and duration.” Bake takes the view that Asia has been playing catch-up and is only now representing the proportion of global or emerging market flows it long should have done. “I do think you can replicate it. It was not a one-off.”

The bigger question will arise when the rates environment does change, and equity capital markets become an option once again. Will the renewed importance of Asian DCM continue to stand up when that happens? If it does, then this year will be seen as the moment a substantive change in Asian funding took place, and not just a function of wild markets.